Days Sales Outstanding DSO: Meaning & Interpretation

Days Sales Outstanding (DSO) represents the average number of days it takes credit sales to be converted into cash or how long it takes a company to collect its account receivables. DSO can be https://www.bookstime.com/ calculated by dividing the total accounts receivable during a certain time frame by the total net credit sales. The period of time used to measure DSO can be monthly, quarterly, or annually.

• Broadly speaking, a DSO ratio of 45 days or fewer is often seen as ‘good’ for most companies.
• A company’s days sales outstanding (DSO) is the average number of days it takes the business to collect payment over a period following a sale.
• Days Sales Outstanding (DSO) is the average number of days taken by a firm to collect payment from their customers after the completion of a sale.
• For example, a manufacturer selling heavy equipment is more likely to have a higher DSO than a service business.
• Your team should aim for a DSO that aligns with your industry standards and supports your cash flow needs without compromising customer relations.

Example of a DSO calculation

For example, let’s say you have $20,000 in accounts receivable and sold $10,000 on credit in a 30-day period. Using the DSO formula, you find it takes an average of 60 days to collect your invoices. Most business owners compare figures quarterly or annually, not over prior time periods. The days-sales-outstanding formula divides accounts receivable by total credit sales, multiplied by a number of days in a measurement period. Since cash is extremely important for business operations, the quick collection of accounts receivable is in the best interest of the company. Furthermore, DSO can also be used to examine the company’s overall efficiency and profitability.

• Better than the average – which we all know isn’t that insightful – you’ll find below the median DSO for different industries.
• But sending out invoices as soon as possible once you’ve delivered a product or service is one action you can take to improve the speed of payment speed.
• Invoices are sorted by status, with overdue invoices listed first, making it easy to see who owes you.
• In this post we explain the why, what and how of this important metric — before explaining how process mining can improve DSO ratios.
• A company with a low proportion of credit sales will have a DSO that does not provide much insight into its cash flow situation.
• And by comparing your current performance against your potential, you can more easily identify efficiency challenges.

Risk management

Looking at a DSO value for a company for a single period can provide a good benchmark for quickly assessing a company’s cash flow. It suggests how efficient the company’s collections department is, and the degree to which the company is maintaining customer satisfaction. In general, small businesses rely more heavily on steady cash flow than large, diversified companies. Using this formula, the company will find that, on average, it takes them a little under 18 days to collect payments after a sale has been made. Such challenges result in late invoices, incorrect terms, invoice rejections, underpayments, late payments and non-payments. But it’s one thing to know there are issues, and quite another to pinpoint where and why they occur or prioritize how they’re addressed.

Days Sales Outstanding vs Accounts Receivable Turnover

Based on data from the Hackett Group 2022 Working Capital Scorecard , the overall average DSO in 2021 was 40.6 days, but the median for the 1,000 companies analyzed was higher at 48.7 days. That said, take this data with a grain of salt since DSO varies widely across (and even within) industries. Discover how generative AI is transforming AP automation in 2024 with trends like invoice processing, fraud detection, predictive analytics, and ERP integration to streamline your financial operations.

Why calculate days sales outstanding?

Offering incentives for early payments is known to accelerate the payment process, as discounts and early-bird offers are well-received by customers. You can also penalize your customers if they are consistently late with payments. Make sure that your invoices contain the late fee terms and conditions, so that dso meaning the customers know about them up front. In the worst case, you would have to face negative cash flow, meaning you may end up taking loans to manage your business finances. Sending and tracking your invoices automatically reduces human errors  – which we tend to underestimate and reduces cash flow problems.

Carry out regular credit checks on new and existing customers

An effective way for businesses to use the DSO calculation is to keep it tracked month by month on a trend line — or a series of plotted data points indicating a certain pattern or direction. Using the DSO in this way can help companies see any changes in their business’s ability to collect payments from customers. A seasonal business can use a variation of this analysis by tracking the same month’s metric on a year-by-year rate. With this granular view of accounts receivable process issues (or opportunities), you have the data to quantify their impact on KPIs like your DSO ratio and cash flow. This not only establishes a clear order of priority when it comes to addressing them, but also underpins the business case for any investments required to optimize the processes. Computing the DSO monthly, quarterly, or annually helps businesses understand how quickly they receive or collect cash for their credit sales.

• Regularly communicate with clients regarding their account status, upcoming due dates, and any overdue balances.
• Now, we can project A/R for the forecast period, which we’ll accomplish by dividing the carried-forward DSO assumption (55 days) by 365 days and then multiply it by the revenue for each future period.
• In this metaphor, the time it takes for customers to pay their tabs is akin to DSO for a business.
• Because this is an average general KPI, though, choosing a time period that’s too low may introduce undesirable artifacts in the data.
• While it provides useful information about the efficiency of accounts receivable, it does not offer a complete picture.

More importantly, the focus should be less on the absolute DSO number and more on its trend over time. A sudden increase in your DSO – for example, from 30 to 45 days – is a red flag. Such a shift indicates a potential issue in how efficiently your business is managing its receivables. It’s not necessarily a cause for concern but certainly signal for closer examination and possible intervention. Consistency or improvement in DSO figures is generally more favorable than fluctuating or increasing trends.

Applications of Days Sales Outstanding